PICKING THE RIGHT APPROACH
Currently, APRA is the only regulator to adopt the Pillar 1 approach for IRRBB. APRA’s decision was driven by its finding that IRRBB risk was significant for Australian banks and yet they were allowed to use their internal models to gauge their Banking Book interest rate risk exposures and not to reserve capital for these exposures.
As a result, major Australian banks have prescribed RWA requirements coming from their Banking Book interest rate exposures, prompting them to actively manage their RWA or capital requirements. Further, these measures are disclosed to the markets every quarter.
While the Basel Committee concluded that the Pillar 2 approach would be better suited to capture the diffuse nature of IRRBB,5 the performance of Australian banks can be viewed as a vindication of APRA’s decision to adopt the Pillar 1 approach.
With their upgraded risk models, the country’s banks have succeeded in managing their exposure to risk, in return saving millions of dollars in capital requirements.
For the quarter ending March 2019, while ANZ cited lower exposure to yield curve risk and repricing as drivers of a reduced IRRBB charge, National Australia Bank (NAB) reduced its IRRBB RWA by 22% y-o-y while Westpac slashed IRRBB RWA by 45% y-o-y. Commonwealth Bank of Australia (CBA) achieved the greatest savings of the Big Four Australian banks, achieving a 54% y-o-y reduction in IRRBB RWA.6
These outcomes highlight the effectiveness of mandating explicit capital requirements as espoused by the Pillar 1 approach, and its ability to inspire greater discipline and active management of IRRBB compared to the more opaque nature of the Pillar 2 approach.